Tags: Warren Buffett | deal | valuation | investing

Buffett's Latest Billion-Dollar Deal Offers Timely Lessons

Monday, 10 August 2015 02:01 PM

Warren Buffett’s latest acquisition was the $37 billion purchase of Precision Castparts. After Buffett buys a company, we have a chance to review the value of the deal to learn what Buffett looks for in an acquisition.

Precision is an industrial company that makes parts for planes, generators and other products. It’s an easy-to-understand company.

This is important because it’s easier to value simple companies. To value a tech company, you need to analyze the competition. To analyze old economy companies, all you need to look at is its earnings and cash flow.

Popular investment tools made Precision look expensive before the deal. The price-to-earnings ratio was higher than average based on trailing or expected earnings. Both the price-to-sales ratio and price-to-book ratio were higher than average. Its dividend yield was low at less than 0.1 percent. PCP fails to qualify as a value stock using the most popular tests.

What Buffett noticed in Precision is provably value relative to the company’s earnings before interest, taxes, depreciation and amortization.

Buffett has called Ebitda a measure of “owner’s earnings.” As an owner, Buffett could pay off the debt and reduce interest to zero if he chooses to.

His decisions can influence the tax rate and the amount of depreciation the company recognizes. Buffett, or any owner, is in a position to maximize Ebitda.

Buffett is paying about 11 times Ebitda for Precision. Generally, readings below 12 indicate value.

Right now, about one-fourth of the stocks in the S&P 500 have low enterprise value to Ebitda ratios, a sign that this market might not be as overvalued as many investors relying on simple P/E ratios believe.

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MichaelCarr
Warren Buffett's latest acquisition was the $37 billion purchase of Precision Castparts. After Buffett buys a company, we have a chance to review the value of the deal to learn what Buffett looks for in an acquisition.
Warren Buffett, deal, valuation, investing
274
2015-01-10
Monday, 10 August 2015 02:01 PM
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